Do Markets “React” to Economic News?

One doesn’t have to be a strict methodological individualist to appreciate that collectives don’t think, act, and choose. Yet one of the standard tropes of financial journalism is the idea that the stock market, like your broker or your Aunt Sally, “reacts” to this or that bit of economic news. “Stocks Soar on Summers Withdrawal,” screams this morning’s Reuters headline. This reporter has some serious powers of discernment: trading Friday “was subdued ahead of the Federal Reserve’s expected reduction of stimulus measures next week.” “In reaction to the withdrawal of Mr. Summers, the dollar slipped to a near four-week low against a basket of currencies.” And: “Further whetting risk appetite were signs of progress in Syria following a Russian-brokered deal aimed at averting United States military action.”

Of course, this is all pure invention on the part of the reporter. Nobody knows for certain why a stock-price average goes up or down. Think about it. The prices of individual stocks reflect expectations of future dividends and future price movements, and they go up and down as new information is revealed about the firm and its competitors. We can never know for certain what makes people buy and sell particular shares but, in the case of an individual firm, we can reasonably infer that shareholders as a group are reacting to new information about the firm. The firm announces quarterly earnings below analysts’ expectations, the share price tends to fall. A competitor announces bankruptcy, the share price tends to rise. Event studies are a popular technique for quantifying investor reactions to news and events related to particular firms.

But the stock market as a whole doesn’t work this way. Stock prices go up and down, and indexes like the S&P 500 and DJIA go up and down according to the performance of their member stocks. Sometimes the average rises, sometimes it falls. Duh. The idea that movements in the index necessarily embody the reaction of the market as a whole to some piece of aggregate economic news reflects a failure to grasp the concept of an average. Of course, it’s always possible that investors’ beliefs about the prospects for particular stocks reflect shared concerns about the economy as a whole. If the government announces an increase in the corporate income tax rate, the prices of many stocks will likely fall. But this applies only to the most obvious cases. Did lots of investors care about Larry Summers’s withdrawal from the Fed race, enough to make them start buying stocks? Who knows? Clearly financial journalists — who are paid to write about such things — care a lot about the next Fed chair. But we have absolutely no idea how much investors care, and no way at all to attribute this morning’s rise in US equity prices to the Summers announcement or any other piece of economic news.

So please, can we stop taking such pronouncements seriously? The stock market is a social institution, an aggregate of individual trades and traders. Let’s stop anthropomorphizing it.

But what’s interesting about what you’re seeing here is that it’s socially general: people need to cognate about social aggregates by anthropomorphizing them, and constructing dramatic stories about how those characters interact, usually implicating ethical harms and debts and karmas to be repaid upon one another. They do it with countries and little leagues too.

I think as economics thinkers we’ve got to do better than complaining about the public’s tendency to anthropomorphize the economy, and understand how this mode of social cognition actually influences economic outcomes. For 150 years we’ve been trying to show people with diagrams and high-school algebra that their intuition of the economy as good guys, bad guys, fearful guys, nurturing guys, selfish guys, and generous guys — is wrong.

The persistence of this alleged stupidity may be the reflection of our own stupidity in repeating an unpersuasive political economy to people for decades and expecting them to finally get it. ;) We have to understand how the economic language people are used to speaking in actually works, and speak it to them, if we’re going to persuade them.

I’m looking at the same type of stuff Gabriel Rossman is, revisiting the anthropologists like Mauss and Malinowski in how reciprocal giving is foundational. Connecting this with George Lakoff’s observation in Philosophy in the Flesh, that people constantly use language to express a sort of tally-sheet of ethical harms and credits that motivate behavior, I think we can start to see how ethical reciprocity is a sufficiently general decision heuristic, and how keeping track of a rough narrative of who’s harmed whom, who’s benefitted whom, and who owes whom, is actually a functional social mechanism.

As far as understanding the stock market and stories about it, I think we need to understand how the history of it developed. Where exactly did this foundational idea come from that somehow it is a General Social Barometer? Is there any evidence to support that? Economists tend to scoff at the consumer and producer confidence indices. Can we do better? What about text analyses of financial press to see if they correlate or predict stock movements? I talked to George Akerlof about this and he thought it was a good idea. And I know Goldman Sachs is interested in it.

It’s not easy to understand how the stock market is rhetorical, because that idea clashes really violently with a lot of the traditional thinking us market sympathizers have been led to use in order to understand markets (as against for instance the largely incorrect Marxist narrative of financial markets). But that doesn’t mean narratives generally don’t make it tick. Hmmm.

This reminds me of a short post I had about “What markets say”:
We often hear that markets want such and such policy. Or that some changes in the market were caused by some announcement. Such narrative is attractive for the media, but such claims have no rigor or value.
The only information generated by markets (of any kind) are prices and trade records. Anything else is speculation or anecdotal opinion (often from a single perspective, such as sellers), if not plain propaganda.

5.Graham Peterson | 16 September 2013 at 11:35 pm

Ultimately the price system is a reduced-form system for expressing preferences, and in that way is a language system. I know that kind of claim is usually leveraged by say a left anthropologist to say that prices are ultimately a bad or undemocratic way to express preferences, that it lacks nuance, or full body, etc. That’s not my claim. But I do think it’s true that markets are ultimately rhetorical, and there really is something to the idea that the market quite literally speaks. It’s natural to talk about the people, or polity speaking, through the vote. Well, ultimately voting and prices are both preference aggregation systems, and the public and private discourse about them in the press too.

Not that I dispute the dreadful Just So theorizing of most financial hackery, but, sadly, I think the rest of the comment is sadly awry.

It WOULD be true if we did not live in a world totally dominated by block derivatives, ETF baskets, High-Frequency algo trading and a whole host of other self-referential ‘collectives’..

I think it’s really sweet that people actually believe that cautious sages sit down each day to pore over the minutiae of business performance, managerial intent, and capital structure and then tentatively submit the bids and offers suggested by the fruits of such dispassionate lucubrations!

Peter, my point is that the ‘market’ as a Borg-like whole is brought closer to the journalistic cliche by the fact that so much trading is either effected by symbol- driven automatons battling in cyber space (and hence plagued with near instantaneous feedbacks) or is traded as a whole index, or a marketing- hype bloc theme in the dominant ETF space.

Flash crashes and mass, indiscriminate switches in direction are the reality, not an emrgent average of a multitude of individual stock changes, each moving according to its own idiosyncracies.

But, yes, fin journalists make sports writers look like Hemingway!

10.Dante Pozzi | 18 September 2013 at 6:49 am

Corrigan, I´am with you on that one. Mostly because of your second factor – stock are indeed mostly traded as a whole.

11.Jim Rose | 27 September 2013 at 6:31 am

See The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb by Joseph Michael Newhard, August 27, 2013 at http://www.terry.uga.edu/events/details/2444 for a replication study of Alchian’s event study of capital market reactions to nuclear detonations in 1954 updated with declassified information and modern finance theory.

Newhard makes the point citing Romer (1993) that “outside observers very often cannot identify any news that could plausibly have been the source of observed changes in stock prices,”

Romer’s paper notes that the majority of major share market price changes do not follow news. These prices changes are due a process of discovery and mutual learning. the revelation of information by the trading process itself see investor uncertainty about the quality of other investors’ information decline and prices firm-up.